EPAct 179D Experts

"The least expensive kilowatt, is the one not used."

- Jacob Goldman

The Energy Tax Aspects of Drug Stores

The drug store sector has undergone tremendous growth in recent
years and has seen the emergence of national sector-wide domination
by three companies: Walgreens, CVS and Rite Aid. As the industry has
evolved to three leading companies they have increasingly focused on
energy management. With proper tax planning, considerable tax
incentives are available to complement these companies’ advanced
energy efficiency initiatives.

The EPAct Tax Opportunity

Pursuant to Energy Policy Act (EPAct) Section 179D, drug store
owners or tenants making qualifying energy-reducing investments can
obtain immediate tax deductions of up to $1.80 per square foot.
If the building project doesn't qualify for the maximum $1.80 per
square foot immediate tax deduction, there are tax deductions of up
to 60 cents per square foot for each of the three major building
subsystems: lighting, HVAC and the building envelope. The building
envelope is every item on the building’s exterior perimeter that
touches the outside world including roof, walls, insulation, doors,
windows and foundation.
The following chart illustrates the potential total EPAct tax
deduction for the major drug store chains:

Notes:
1. Walgreens recently purchased Duane Reade a regional chain with
a major market share in New York City.
2. Duane Reade Square footage based on 7,100 square foot store
size average from 2003.
3. Based on 12,500 square foot average store size from 10-K.

Drug Store Tax Planning

Lighting

Building lighting comprises a large portion of drug store energy
use. It is important to realize that effective January 1, 2009, most
probe-start metal halide lighting may no longer be manufactured or
imported into the United States; and, effective July 1, 2010 most
T-12 lighting may no longer be manufactured or imported into the
United States. Fortunately, the leading three drug store companies
are all ahead of the pack in this regard, as they have recently
upgraded to at least T-8 lighting . A lighting retrofit, like these
companies have done, can easily reduce lighting electricity costs by
40 to 60 percent. The following chart shows when EPAct lighting tax
savings are applicable for typical drug store spaces:

LED Lighting Conversion

Previously most lighting upgrades were to T-5 or T-8 fluorescent
bulbs; however the recent trend has been to upgrade to the new
technology, LED lighting . The leading three drug stores have
started to phase in LED lighting, and we anticipate that in the near
future they will fully convert to LEDs. For example, CVS has started
to replace all of their lighting in noncritical store areas with
LEDs , and in Walgreens’ newest stores LED lighting is used in the
coolers, freezers and exterior signage . We believe the next step
will be upgrading to LEDs for all mainstream store lighting. This
would enable the drug store owners to take immediate substantial
EPAct tax deductions.

HVAC

In addition to upgrading lighting, drug stores should utilize new
HVAC efficiency package units and where feasible chillers. Store
owners should take their most efficient store, combining the LED
lighting discussed above, and the most efficient HVAC and have it
modeled using IRS approved software to see if it qualifies for
multiple EPAct tax deductions . With this approach, they could plan
into $1.20 to $1.80 EPAct tax deductions for every store retrofitted
to that energy efficiency level or better on or before December
31st, 2013.

Building Envelope

There are also drug store EPAct tax deduction opportunities for
energy efficienct upgrades to the building envelope. Examples of
energy efficient upgrade opportunities for the building envelope are
new roofs and improved insulation. For instance, in Walgreens’ LEED
certified store in Chicago, the roof was built with a white coating
and plants growing on top (commonly called a “green roof”) and CVS
constructs all of their new stores with white roofs made out of
environmentally preferable materials . Sometimes the forgotten EPAct
tax deduction opportunity, imporvements to the building envelope can
contribute in large ways to receiving full $1.80 EPAct tax
deductions.

LEED Certified Stores

If they have any existing LEED (Leadership in Energy and
Environmental Design) stores, drug store owners already have a store
that has an energy simulation model and it could quickly be
evaluated to see if multiple EPAct tax deductions are in the offing.
For example, Walgreens has LEED stores in Mira Mesa, CA and Chicago,
and has four more LEED projects in the process . CVS has a LEED
store in La Quinta, CA and Rite Aid utilizes architecture and
engineering firms with LEED accredited staff . This gives these
organizations an advantage. These companies should first determine
whether existing LEED models can be converted to EPAct models that
already qualify them for tax savings. One planning technique is to
take a beta store with optimized lighting, HVAC and building
envelope efficiency, and to lock it in to trigger major deductions
in multiple stores.

The three main drug store companies are in continuous and growing
competition with each other. It is interesting to note that the
first CVS and Walgreens LEED stores are less than 200 miles from
each other. In highly populated areas all 3 major drug store
companies often will have stores in close proximity to one another
other. Once a market is this saturated, achieving top line sales
growth is challenging. Therefore, all operating cost reduction
including energy cost reduction becomes crucial.

Distribution Center Tax Savings

Drug store chains can also obtain large immediate EPAct tax
deductions by retrofitting their distribution centers and
warehouses. As noted by CVS, these companies have already upgraded
their distribution center lighting . The next step for
non-conditioned distribution centers is to upgrade to new energy
efficient heating systems, such as Cambridge systems, and trigger
full EPAct deductions . There are multiple heater technologies
suitable for the distribution center market, including direct fired
gas heaters, unit heaters, and infrared (radiant) heaters. If
feasible the heater should be mounted on an exterior wall to
optimize the roof top solar P.V. space. As can be seen by the
following chart, some of the drug store chains mentioned above have
very large amounts of distribution center space that are potential
candidates for EPAct deductions:

Like retail stores, distribution centers need to be modeled using
IRS approved software. CVS is currently building a distribution
center in Chemung County, NY that it expects to be LEED certified.
This area of northern New York will require a warehouse heater, and
a highly energy efficient heater should support EPAct tax
deductions. The existing LEED model can be analyzed to determine the
opportunity to convert to an EPAct model supporting back tax
deductions.

Conclusion

The “Big 3” drug stores have become a very important property
category that has recently experienced a large increase in store
units. In fact, the drug store sector has become a leader in energy
efficient technology upgrades. However, in order to be more
competitive these companies need to take the further steps mentioned
above to continue to lower costs and trigger larger EPAct tax
deductions. Continued installation of energy efficient equipment,
combined with the appropriate tax planning, will be an important
element for continued success in the drug store sector.